Markets rallied Monday on the news that President Donald Trump and Chinese President Xi Jinping agreed to restart trade negotiations and that the U.S. will rollback some export restrictions on Chinese telecom giant Huawei Technologies Co. Ltd.
Analysts and strategists, however, warn investors not to get too excited about the deal, given that scant details were given by either government on the schedule of new trade talks, because existing trade barriers remain in place and there is no guarantee that new barriers won’t be imposed if relations sour.
“A pause in rising trade tensions is not a fix for slowing U.S. economic activity and earnings pressure,” wrote Michael Wilson, equity strategist at Morgan Stanley, in a Monday research note. “In November, a truce brought a short-lived rally to the S&P, but ultimately induced procurement managers to cancel orders as inventories were already high and there was no longer an incentive to stockpile ahead of incremental tariffs.”
Wilson said this time around, “the set up will be similar,” but the reaction potentially worse, given that economic data are pointing to a slowdown in the U.S. and abroad.
“The S&P 500 SPX, +0.77% rose close to 1.5% on the Monday after the [November trade truce]. Sound familiar? Well, after that one-day pop on December 1, the S&P 500 then had its worst December on record,” he wrote. Monday’s equity-market rally was already fading in afternoon trade.
Aditya Bhave, global economist at Bank of America Securities agreed, writing in a note to clients that “The markets are likely to view the summit as modest positive in the short run, but stepping back we see several reasons for concern.” Those include the continued existence of 25% tariffs on $250 billion in Chinese imports and an average 20% tariff on $110 billion in U.S. exports to China.
“Tariff termites have been eating away at growth in China and its trading partners in Europe and Asia-Pacific. In the US, the manufacturing sector has started to weaken,” Bhave wrote.
Bhave predicts it unlikely that the Trump administration will make any major concessions needed for a trade compromise until there is a significant market correction of 15% to 20%, or evidence of a significant slowdown in the economy.
Additionally, he warned investors of a “perverse feedback loop between the Federal Reserve’s attempts to support the economy and President Trump’s incentives to re-escalate various trade conflicts,” as long as stock markets don’t react too negatively.
“If this ‘Powell Put’ and ‘Trump Call’ are strong enough, they could create an ever-escalating trade war matched by an ever-lower funds rate,” he wrote, referring to the notion that the Fed will respond by loosening policy and providing liquidity in the wake of market turmoil and that Trump will take advantage of rising stock values to drive a harder bargain with the Chinese and other trade partners.
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“The stock market would be left in a range-bound “collar” trade, with its upside and downside capped by the trade war and the Fed, respectively.”
But the Fed doesn’t have the power to fully offset the costs of an escalating trade war, if talks break down once again, and ever more trade barriers are erected. “Rate cuts will become increasingly less effective in countering the shock [of new tariffs] , he added. “Even lowering borrowing costs by 2% cannot make up for the risk of a 25% tariff.”
